This past Thursday I had the distinct pleasure of spending 4 hours with Stan Harley, the publisher of The Harley Market Letter. He shared some interesting insights in two canary in the mine real estate markets – Los Angeles and Phoenix and further detailed what can be expected for interest rates in the future. What was astonishing to me is just how powerful market cycles are and how they can be used to hedge one’s bets and to be proactive and not just reactive. Many of the seasoned real estate investors understand there are cycles to all business activity, but few understand simple analysis can be utilized to avoid game changing and unexpected shifts in the market place. Mr. Harley believes that even external events really have no bearing on the math.

Most business strategists and real estate professionals failed to identify the key pivotal turns for the housing market in 2006 and 2012. Market timing – as most are well-aware – is an extraordinarily difficult task. The foundation which underlies the basic principles of his analytical methodology is that market behavior can be described (and predicted) through a combination of simple cycles of differing periods. Cycles are the essential factor in determining how long a trend should run and when to expect reversals.

“The knowledge and exploitatin of cycles embodies one of the most powerful analytical tools available for identifying trends and forecasting their reversale.” Stan Harley

CASE-SHILLER HOME PRICE INDEX

The Case-Shiller home price index tracks the value of residential real estate in 20 metropolitan regions across the United States. There are multiple Case-Shiller home price indices: A national home price index, a 20-city composite index, a 10-city composite index, and twenty individual metro area indices. The index is published on the last Tuesday of each month, with a two-month lag. The graph above depicts home price data from 1890 through the present. The lower graph reflects data for the Phoenix, AZ area region through Q3 2016.

Data for the Phoenix region is somewhat limited compared to the national data as well as data for the southern California region. Because the economies of Arizona and Southern California are inextricialby linked – and the cyclical funcitons for both etch-out similar wave forms – a detailed analysis of the Los Angeles region can tell us alot about the market timing functions for the Phoenix area region. A cyclical analysis of the Los Angelia area region, the largest in the United States, is depicted below. Data for Phoenix and the rest of the country are very similiar.

(Editors note: I forwarded slides from the local AZ Real Estate Investors March market presentation(some of which were from the Cromford Report). Mr. Harley was not surprised they matched up.)

COMPOSITES ARE BACK TO THEIR WINTER OF 2007 LEVELS

Editors Comment–The Canary is in the coal mine.

HOME PRICES ARE PEAKING

Since his last review of the Case Shiller index Mr Harvey has revised his cyclical modeling to the numbers shown in the box above. The baseline cycle appears to be 196.8 months or 16.4 years. Notice how this cyclical function defined the June 1990 – Sept 2006 peaks and the March 1996 – February 2012 lows.
The analysis points to a peak for the Los Angeles area – as well as the National Index overall – in the December 2016 time period. Because of the two month lag in the publishing of the data, we won’t know whether home prices have peaked for several more months. He also noted a narrowing in the range of the monthly price bars – a phenomenon that also occurred at the prior cyclical highs. However, based on the updaded data from the AZREIA slides for the period ending February, 2017, the trend is esclating.

At this point Stan Harvey is predicting a minimal drop of 12% in housing prices.

The Harry Dent team is suggesting a drop of 20% in housing prices.

Personally, I have noticed Days on Market are increasing. One of the local reps of a national title company here in Phoenix suggested they have seen a dramatic slowing in pricing for homes in central Phoenix.

Another title company rep noted their March has been VERY slow. A sales rep from a large local lender said their applications for March are way down.

Long term, Mr. Harley is predicting the big one in February, 2023

INTEREST RATES

Mr. Harley made one basic statement on interest rates. They will come down. Period.

HOW DOES THIS IMPACT NOTE BUYERS?

For note buyers keep your powder dry. Only buy notes with a strong equity position behind them. Another words be patient, and buy notes with a loan to value of less than 70%, preferrably less than 65% – all of which is subjective to mitigating factors. If one maintains that cardinal principal, then even with a potential property value drop of 20%, the chances of a payor walking are minimal.

HOW DOES THIS IMPACT NOTE SELLERS?

Make sure you get at a minimum of 10% down, preferrable 15% – 20% down from your buyer. Continue to require at least an 8% interest rate on your note from your buyer–preferrable 10%, but stay in line with the Dodd-Frank Act requirements. There are multiple posts regarding The Dodd-Frank Act on this site.

HOW DOES THIS IMPACT IRA INVESTORS?

It is all positive. Be conservative and positive. If market interest rates drop as forecasted, seller financed notes continue to be a rewarding investment alternative.

PS–It is all about being proactive and NOT reactive. Alot of money can be made in a down cycle–more than in an up cycle.